Transper Pricing

Transfer pricing provisions primarily require any income arising from an international transaction between two or more Associated Enterprises (‘AE’) to be at arm’s length price and comparable to similar transactions between unrelated enterprises.

OBJECTIVES OF TRANSFER PRICING?

Chief Executive of a big company cannot monitor and control operations of each and every sub-unit. So the sub-units are turned into Investment Centers and necessary authority is delegated to their managers.But in a decentralization, there are difficulties in evaluating the performance of the managers. Further, there is a problem of coordination. So a method is needed to ascertain contribution of each sub-unit to the total profit of the organization. A common solution to this problem is to set prices for intermediate goods which are transferred from one division to another. These prices are known as transfer prices to be used for:

Performance evaluation of each manager based on the contribution made by the sub-unit.

Coordination of all sub-units for achieving the organisational goals.

Deciding what to charge for transfer a product or service to the next department.

to preserve autonomy of a sub-unit.

Motivation of the managers as they would certainly get rewards for good performance through a transparent system.

Methods of Transfer Pricing

1) EXTERNAL MARKET PRICE

If an external price is available, it would be a good price indicator. The transfer price should be the same as market price less an amount representing savings in packing and transportation cost etc.

In an ideal situation, a sub-unit would have an option to sell directly to the maket should a reasonable transfer price is not agreed upon. Same is the case with the buying department.

2) COST PLUS MARKUP

Sub units can fix a markup on cost to get a reasonable return which would enable them to achieve the required ROI. Such a markup may be based on variable cost or full cost. It...